Equity Market Neutral in 2024

December 19, 2024

3 minute read

by Jina Yoon, Chief Alternative Investment Strategist, LPL Financial

With additional content provided by Michael McClain, AVP, Research.

As we enter the final weeks of 2024, one of the strongest alternative investment strategies this year has been equity market neutral investing. Through the end of November, the HFRI Equity Market Neutral Index has gained 10.2%, with a beta to the S&P 500 of only 0.04. As compared to the rest of the alternative investment sub-strategies, only the HFRI Equity Hedge Index has performed better, albeit this index has a consistently higher beta profile which is especially valuable when the broader market is up over 25% on the year.

HFRI Sub-Strategy Returns Through 11/30/2024

Source: LPL Financial Research, FactSet, 12/16/2024
For more information on the HFRI indexes: https://www.hfr.com/family-indices/hfri/

Strategy Background

Market neutral strategies are designed to generate returns by exploiting pricing inefficiencies while also minimizing exposure to overall market movements. This involves a portfolio manager taking both a long (buy) and short (sell) position in different securities. The offsetting positions may involve pairs trading in similar securities or, more often today, going long securities exposed to positive long-term factors such as value, quality, or momentum to name a few. Short positions are then initiated in securities with limited exposure to these long-term factor premiums. Regardless, the goal is to profit from the price differences between securities, regardless of whether or not the market is up or down, as these strategies will have equal levels of long and short positioning. Many funds are also sector and industry neutral, meaning long and short exposure is balanced across sectors and industries to avoid sector-specific risk.

Often driving performance in the industry is the level of dispersion within and between sectors. Higher levels of dispersion provide greater alpha opportunities from long and short stock selection and can also improve the benefits of diversification. In contrast, when stocks within a sector are moving more closely together, the ability to profit from both long and short positions is reduced, as one side of your exposure will be moving against the current market direction. To put dispersion into perspective, while the information technology sector is up 40.8% through December 16 of this year, the top performing stock is up over 300%, and the worst performer has declined over 59%. A performance spread within a sector of over 350% creates a ripe opportunity for long and short positions, which many strategies have capitalized on this year.

Summary

While 2024 has been an exceptionally strong year for equity market neutral investing, we can see in the chart below that the industry has faced stretches of difficulty over the past 10 years. Much of this was due to lower levels of volatility and stock dispersion, combined with interest rates at all-time lows. However, looking ahead, we’ve become more constructive on the space, as interest rates appear to be leveling off at a higher-than-expected level, while President-elect Donald Trump’s policies may also lead to increased market volatility and stock dispersion. As market participants digest changes and subsequently begin to distinguish between firms positively and negatively impacted, strong fundamental equity market neutral stock pickers may become increasingly attractive.